Debt Ceiling Contingency Plans

What will the Treasury do if there's no increase in the debt ceiling? What should you do?

Back in April I wrote a post about what would happen if the debt ceiling were not raised. I suggested that the Treasury could deal with a cash shortage the same way Illinois had — by delaying some payments and prioritizing others. I also suggested that Congress, seeing the Executive branch grab all that power, would move quickly to end that experiment.

Can the Treasury Prioritize?

Everyone has been assuming that the Treasury will respond by prioritizing certain payments — interest on the debt will be paid, social security will be paid, soldiers will be paid — and that other bills will be deferred.

The Treasury has been at pains to refute this assumption:

Treasury officials have maintained that the department lacks formal legal authority to establish priorities to pay obligations, asserting, in effect, that each law obligating funds and authorizing expenditures stands on an equal footing. In other words, Treasury would have to make payments on obligations as they come due. — Reaching the Debt Limit: Background and Potential Effects on Government Operations (PDF)

Beyond statements like that, the Treasury (and the Federal Reserve) have been quite steadfast about refusing to discuss contingency plans.

This is primarily a tactical move. Their position is that not raising the debt limit is unthinkable. Any indication that they're thinking about it would tend to undermine that position.

Still, their position is not unreasonable. Several presidents have tried the tactic of not spending all the money that Congress had appropriated — sometimes because they didn't like the program the money was being spent on, other times because they wanted to reduce government spending. Whenever this has been done, the courts have ruled against the practice. Congress has the power to spend money; the president has no power to "just not spend" money that Congress has appropriated.

Of course, this is a special case. The power to tax and to borrow also belongs to Congress. When Congress chooses not to get the arithmetic right — when the spending is greater than the sum of the taxing and the borrowing — the Treasury is placed in an untenable position. When it's impossible to follow the law, the Treasury has to make a choice. Currently the Treasury is playing its cards very close to the vest. There were rumors that it would provide some hints as to its contingency plans last night or today, but so far it has not.

Prioritizing payments has been the preferred strategy of the House Republicans who have been most adamant about refusing to raise the debt ceiling. They claim that the government should just live within its means, and that refusing to raise the debt limit, combined with prioritization, would be a way to force that.

Other people point out that the arithmetic goes against this strategy very quickly. Once you pay for Social Security, Medicare, Medicaid, the Defense Department, and unemployment, you've already spent all the money.

As I explained in my post Stalemate on the Debt Ceiling, that's not how I figure things will go — because government contractors will go on providing services for some time, even if they aren't getting paid, so those are the bills to not pay. Seniors would still get health care (for a little while), even if the Medicare service providers didn't get paid. Fuel for fighter jets would still get delivered (for a little while), even if the oil companies didn't get paid.

I still think the most likely option would be for the Treasury to prioritize spending. It would pay the interest on the debt, it would pay Social Security, it would pay federal employees (perhaps after laying off non-essential ones), it would pay soldiers. What it wouldn't pay would be the ordinary business debts of the government — defense contractors, drug companies, landlords, utility bills — including the big ones, like payments for Medicare and Medicaid, etc. (No smart drug company executive would quit delivering drugs to a VA hospital just because its bill was a bit late getting paid.)

And, as I said, I think Congress would cave pretty quickly, once business interests found that they were still providing services for the government, but were no longer getting paid.

Other Options

With the Treasury being so coy, I thought I'd at least touch on the other possibilities.

Pay Late

The Treasury has hinted that it would just pay the government's obligations in the order that they were due, making payments as and when the money arrives. For the first few days, we'd just be paying a few days late. Very shortly after, we'd be paying several days late. They'd treat every debt the same, including interest payments on the national debt. The result would be technical default almost immediately.

I think that's pretty unlikely. The Treasury is keeping the option on the table to pressure Congress, but managing the debt is the department's whole reason for existence; they'd never willingly make an interest payment late.

Issue Debt Anyway

Some people have pointed to a provision in the 14th Amendment to the Constitution, which says, "The validity of the public debt of the United States, authorized by law, including debts incurred for payment of pensions and bounties for services in suppressing insurrection or rebellion, shall not be questioned," and suggested that the Treasury could call that authority for selling enough debt to make the payments that Congress has already authorized.

I think that's even less likely.

Run an Overdraft at the Fed

The Federal Reserve acts as the Treasury's bank. When someone deposits a government check, the bank presents it to the Fed. The Fed then gives the bank money, and debits the Treasury's account at the Fed. The Treasury's accounts are kept topped off through tax receipts and issuing government debt.

Suppose the Treasury just went right on writing checks, even though there wasn't enough money in the account? The Fed could either bounce the check, or pay it — letting the Treasury run an overdraft.

Paying the check would create money out of thin air, threatening inflation. However, the Fed could "sterilize" that money by selling enough assets to soak up the excess cash.

I see that as almost as unlikely as the 14th Amendment scenario. The folks at the Fed are bankers; they're not going to let the Treasury run an unlimited overdraft.

What You Can Do

I've been wracking my brain to come up with anything clever that individuals can do to make the whole situation less fraught, and I haven't come up with anything.

You could sell your Treasury securities, but what would you do with the money? If U.S. government bonds are no good, in what way would U.S. government currency be better? You could invest in foreign bonds, but which ones? The euro has its own problems — arguably worse than ours, because they're real (while ours are entirely self-inflicted). You could put some money in Swiss francs or Japanese yen or Canadian dollars, but that's a lot of trouble for no particular gain that I can see. You could buy gold, but it's already gone up a lot on the panic trade, and will almost certainly come down if debt problems are resolved.

The only bit of advice I've got is to trust banks over money funds. Money funds invest all their money in just the sort of securities that suddenly become worthless if the markets seize up (as they did after the Lehman bankruptcy in 2008). Banks, on the other hand, have actual assets (loans to local businesses) and they have access to the Federal Reserve to get cash if necessary.

The Treasury has started hinting that it will provide some guidance about its contingency plans before August 2nd. I'll keep an eye out and will post further, if there's any new news.

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This is a very thorough analysis and I particularly appreciate your honesty in the what you can do section, as I've been wondering the same thing. I suppose it always comes back to diversifying across many assets to reduce exposure to any one thing.